Dell, Wells Fargo are Picks for the Value Brave: Greenblatt

NEW YORK ( TheStreet) -- Gotham Capital founder and a value investor legend Joel Greenblatt is betting on beaten-down stocks like Dell ( DELL), Hewlett Packard ( HPQ), General Dynamics ( GD), and Wells Fargo ( WFC) , arguing that the shares are unloved by institutional investors that can't take the short-term risk of underperforming the Standard & Poor's 500.

At the Value Investing Congress in Times Squares Marriott Marquis Monday, Greenblatt argued that "the advantage for value investors is getting stronger as the world is getting more institutionalized." Greenblatt's presentation, which went through the logic of his value thesis also makes him a market bull. "I come away pretty optimistic over the next few years," he said.
Joel Greenblatt founder of Gotham Capital

During the conference -- filled with believers of Benjamin Graham's principle that cheap is good and Warren Buffett's idea that a good business that's cheap is even better - Greenblatt said that by removing the S&P 500 market weight bias that emphasizes overvalued companies and by focusing simply on cheap stocks in the index, investors can find an extra 7% return.

It was an audacious statement given the fact that they S&P 500 beats 70% of active managers each year and virtually over a span of all years that are tracked.

Greenbatt's logic is as follows: By converting the market weighted S&P to an equal weight (meaning that one invests an equal amount in each stock instead of investing based in price) there's a free 2% return.

According to Greenblatt's findings, looking back 20 years from the end of 2010 the S&P 500 had a 9.1% average annual return, while it's hypothetical equal weight had a 11.8% return. The equal weight index "adds back some if the inefficiencies of a market cap index," Greenblatt said. "To me that's still not investing."

Greenblatt and Rob Arnott, who invented the FTSE RAFI 100 index that indexes based on a company's fundamental size, decided to test simply putting money toward cheaper stocks in the equal weighted index. The result was that by emphasizing cheap stocks in the S&P, the value acolytes earned a 16.1% annual return. "I would call this a fairly stunning result," said Greenblatt.

Of the company's that stand out right now in Greenblatt's Value Weighted Index, some like Gamestop ( GME) he says are headed the way of Blockbuster, and others like Best Buy ( BBY) and Aeropostale ( ARO) are "toast" -- and might not be a buy.

HP, Dell, Microsoft ( MSFT), General Dynamics and Wells Fargo are benefitting value investors be because the market is pricing in a unsustainability in future earnings. Fear may be overdone as institutional investors stay away from risky value stocks for fear of underperforming the S&P in the short term, Greenblatt emphasized to conference attendees.

An interesting note, Greenblatt, an anti-hero in Michael Lewis's The Big Short, said that his Gotham fund didn't pull his money from Michael Burry's Scion Capital as was reported in the book. Saying that Michael Lewis "never lets the facts get in the way of a good story," his fund kept its mortgage short using crest default swaps -- it pulled it's bet against corporations.

-- Written by Antoine Gara in New York